U.S. Economic Brief || High headline inflation cuts into real disposable income

High headline inflation cuts into real disposable income

*While core PCE inflation (excluding food and energy) moderated in March – increasing by a modest 0.3% m/m, reflecting easing durable goods prices – headline inflation surged 0.9% m/m and 6.6% yr/yr as gasoline, energy, and food prices spiked in the wake of Russia’s invasion of Ukraine. Soaring consumer prices eroded real disposable income, which declined 0.4 % m/m and has fallen in seven of the last eight months (Chart 1). Nominal consumption advanced 1.1% m/m, largely reflecting higher prices, with real consumption increasing by a modest 0.2% m/m in real terms, boosted by a significant downward revision to January’s data. The personal saving rate fell to 6.2%, the lowest level since 2013, as consumers increasingly draw on savings and current income to meet spending need and smooth consumption.

*Underlying details of personal consumption in March suggest the mix of consumption is beginning to tilt back toward services (Chart 2). Services consumption increased 0.6% m/m in real terms, while goods consumption declined 0.5% m/m in real terms, the second consecutive monthly decline. This shift in consumption is highlighted by robust increases in real consumption of recreation services and food services and accommodation, which increased 1.5% and 1.1% m/m, respectively.

*Nominal personal income increased 0.5% m/m, although flat aggregate hours worked in March despite solid payroll employment growth likely constrained nominal personal income growth over the month. Tight labor markets, elevated inflation and inflationary expectations, and a still strong domestic demand backdrop should continue to exert upward pressure on nominal wages through 2022. If the rate of headline inflation decelerates as we expect in the latter half of the year, real wages and measures of real compensation should begin to pick back up and support sustained real consumption growth.

*The jump in headline inflation was driven by a sharp acceleration in gasoline and energy prices, which increased 18% m/m, and a further pick-up in food prices, which increased 1.4% m/m. Durable goods prices eased, underpinned by a 1.1% m/m decline in motor vehicle and parts prices, although the price of furnishings and household durables accelerated, rising 1.5% m/m. Services inflation gathered momentum in March, increasing 0.4% m/m following a modest 0.2% m/m increase in February. Shelter inflation, which accounts for 15% of the PCE, continues to accelerate on a yr/yr basis, rising to 4.5%, and further increases are likely reflecting the lagged impact of market rents and home prices on measures of shelter inflation. Notably, in a sign of the continued economic reopening, prices of food services and accommodation increased 0.7% m/m while recreation service prices increased 0.4% m/m. The moderation in core inflation largely reflects declining durable goods prices paired with modest increases in healthcare costs of 0.1% m/m.

*The Fed’s preferred gauge of wage inflation, the Employment Cost Index, accelerated in Q1, rising 1.4% q/q and 5.8% on an annualized basis. The sharp monthly increase reflected a 1.2% q/q increase in wages and salaries and a 1.8% q/q increase in benefits (Chart 4). With indicators of consumer demand such as private sales to private domestic purchasers (which increased 3.7% annualized in Q1) pointing to robust consumer demand, the acceleration in nominal wage growth keeps the onus on the Fed to “expeditiously” withdraw monetary accommodation.

Chart 1. Real Disposable Income and Real Personal Consumption

Chart 2. Real Personal Consumption of Goods vs. Services (Index: Jan 2020 = 100)

Chart 3. Headline and Core (ex. Food and Energy) PCE Inflation (yr/yr, %)

Chart 4. Employment Cost Index – Benefits and Wages & Salaries (q/q ann., %)

Mickey Levy, mickey.levy@berenberg-us.com

Mahmoud Abu Ghzalah, mahmoud.abughzalah@berenberg-us.com

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